By Mary Jo Larson and Jennifer Watkins
Warner Norcross + Judd LLP
We have a student debt crisis in the United States. Total student loan debt has quintupled since 2004, bringing the total to over $1.3 trillion. It is second only to mortgage debt.
As a result, many workers are delaying retirement savings. One study found that only one-third of millennials are contributing to an available 401(k) plan. Who can blame them, when student loan debt is an immediate obligation and other life goals such as buying a home or starting a family are being delayed because of it. Retirement seems far off in the distant future.
But it is not just millennials. Some reports indicate that 35% of student loan debt is held by people over age 39. And many parents have taken out loans of their own to help their children through college.
So what is an employer to do? Taking a proactive approach to helping employees pay down student debt can attract and retain employees and can further benefit employees by allowing them to save more and earlier for retirement. But how?
We will discuss four programs an employer can implement, from the easiest and perhaps least desirable, to the most complex but perhaps most attractive.
1. Provide financial education and planning services.
Armed with a basic understanding of math, most people can see that saving early for retirement is a good thing. Some come to this understanding only after seeing the magic of compound interest in the classic example of Person A starting early and winding up with significantly more at retirement age than Person B, who invests more but starts later. However, even if you understand it in theory, how do you squeeze enough out of a debt heavy budget to invest?
A good financial education and planning program can help employees optimize their personal financial situation. These programs are usually not expensive for the employer. But to have even a marginal impact, you need motivated and engaged employees. Many employees will not see this as a significant enough benefit for recruiting and retention purposes.
2. Make loan payments for employees.
Some employers offer employees bonuses and other payments specifically for student loan debt. These payments can be used in strategic ways. For example, loan repayments in the form of:
• sign-on bonuses to attract talented employees
• performance-based bonuses
• bonuses for reaching service milestones, which effectively work as a retention tool
These payments are taxable to the employee and currently give no special tax benefit to the employer. Several bills have been introduced in Congress to provide tax incentives but have not seen much traction yet.
Programs like these would be relatively easy to implement, but employers should run them by benefits counsel to make sure they do not run afoul of any tax code requirements, such as the Code Section 409A rules on deferred compensation.
3. Allow employees to “purchase” repayments with flex spending dollars under a cafeteria plan.
Some welfare plans have a “flex” dollar design, where employees can elect to “spend” their flex dollars on health care and other welfare benefits and cash out unused flex dollars. As an alternative to a cash out, the program can be structured to allow unused flex dollars to be used to repay student loans.
This benefit would be after tax but may still be an attractive option for some employees, who may make different choices regarding their health and welfare options if they can have dollars left over to use toward loan repayments. The program can require that an employee elect at least one medical program benefit, ensuring employees do not forego medical coverage to repay loans.
Employers will want to check with benefits counsel on any kind of program like this to make sure it meets Affordable Care Act, nondiscrimination, and other requirements.
4. Make nonelective contributions to 401(k) plan when employees make loan repayments.
We saved this option for last because, while it is the most complex of the options we have mentioned, it is probably the one in which employers are most interested.
Since one of the biggest concerns surrounding student loan debt is that employees are foregoing retirement savings to pay down student loans, employers have been investigating ways to use the 401(k) plan to address the debt while encouraging savings.
Some student loan vendors have emerged, encouraging employers to add benefits to their plans that offer employees employer-funded, pre-tax contributions to the 401(k) plan if the employees make student loan repayments through the vendor’s platform. It is like a match on the student loan repayments (“SLR Match”).
The challenge in designing these programs is the Internal Revenue Code’s contingent benefit rule, which says other benefits cannot be conditioned on whether an employee makes elective deferrals (with matching contributions being a notable exception).
These vendor programs offer the 401(k) contributions regardless of whether an employee is making deferrals to the 401(k) plan and getting a resulting 401(k) match. This means that an employee who makes elective deferrals and also student loan repayments would receive both the 401(k) match for the deferrals and the SLR Match for the loan repayment.
While this is a great benefit to employees with student loan debt, many employers cannot afford to add an additional contribution to their plan, and some may even feel it is unfair to allow employees to receive both types of contributions, while employees without student debt are only receiving the 401(k) match.
Last fall, the IRS issued a Private Letter Ruling to an employer offering a different type of plan design. The employer, Abbott Laboratories, offered a 5% 401(k) match to employees making elective deferrals of at least 2% of compensation.
The proposal to the IRS was that employees could enroll in a student loan repayment (SLR) program and the employer would make a 5% nonelective contribution to the plan (“SLR Match”) if the employee made a student loan repayment equal to at least 2% of compensation. An employee could also make elective deferrals to the plan, but they could not receive the match on those deferrals and also the SLR Match.
The IRS said this arrangement would be acceptable, with some caveats. Although a Private Letter Ruling only applies to the employer asking for the ruling, it is a good indication of how the IRS would view this design and offers other employers the opportunity to consider similar programs.
There are some important aspects to the SLR Match program described in the ruling to note:
Must be voluntary. The SLR Match program must be voluntary and allow employees to opt out of the program prospectively.
Elective deferrals have no effect. The employee must receive the SLR Match contribution if the employee makes a student loan repayment, regardless of whether they also make elective deferrals. However, if the employee receives the SLR Match, they do not also receive a regular 401(k) match contribution.
Eligible for match if no loan payment is made. If an employee does not make a 2% student loan payment for a payroll period, but does make elective deferrals, they must receive the regular 401(k) match for that payroll period. These can be done as “true up” matching contribution after the end of the plan year. If an employee formally opts out of the SLR Match program, however, the regular 401(k) match contributions should be made each payroll period, if that is the plan’s normal 401(k) match contribution schedule, and not as a “true up” after plan year end.
Can require employment on last day of the plan year. SLR Match contributions and any true up 401(k) match contributions can be subject to a requirement that the employee be employed on the last day of the year. Again, if the employee actually opts out of the SLR Match program, future 401(k) match contributions could not have a last day requirement unless the plan applies it to all match contributions outside the SLR Match program.
Usual plan requirements apply. The SLR Match contributions are subject to coverage and nondiscrimination testing, contribution limits, as well as eligibility, vesting, and distribution rules. Note that the SLR Match contribution would not be treated as a matching contribution for any testing requirements, but any true up 401(k) matching contributions would.
Employer cannot be the lender. The employer cannot be the lender for the student loan. In other words, an employer cannot loan money to an employee for school, and then use a program like this to encourage repayments to the employer.
No set rule on how to verify loan payments. The ruling does not mention how an employer would verify that the employee made student loan repayments. The employer could offer after tax payroll deductions from the employee’s paycheck that would be transmitted directly to the lender. If the employer does not want to take on that administration, some other kind of verification would be prudent (although not required), such as copies of repayment checks from the employee or statements from the lender showing the date and amount of payments. The employer may also wish to consider partnering with a third-party vendor to verify payments and perform contribution calculations.
Matching safe harbor plans cannot do this. Absent guidance from the IRS to the contrary, matching safe harbor plans are not going to be able to implement this type of program because safe harbor matching contributions have to be made for every participant who makes the required amount of elective deferrals. A 3% nonelective safe harbor plan would not have the same issue as long as the plan continued to give the minimum 3% contribution to all eligible participants.
This ruling is welcome news for employers looking for an approach to helping employees repay student loan debt. A program like this would require review by benefits counsel as well as preparation of the necessary plan documentation.
It also adds some complexities for plan testing and administering the program. But it could give employers an edge in attracting and retaining employees in this age of overwhelming student loan debt.
If you’d like to discuss any of the ideas from this guest article, please contact us at Fi3 today.
About the Authors
Mary Jo and Jennifer are both partners in the Southfield office of Michigan based firm Warner Norcross + Judd LLP. They represent clients headquartered in Michigan and across the United States.
Mary Jo Larson puts her 30 years of benefits experience to work on her clients' 401(k)s, pension plans, nonqualified deferred compensation plans, and executive compensation. She also advises fiduciaries responsible for the investment of plan assets.
Jennifer Watkins has 15 years of experience advising employers on the design and operation of their retirement and executive compensation plans.
This article does not represent a specific investment recommendation for any individual client or prospective client. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Information has been obtained from a variety of sources believed to be reliable but not independently verified. Past performance does not indicate future performance.